Lecture 3 - Tariff Analysis-1 | International Economics- In Depth Basics and Analysis PDF Download

 Page 1


TARIFF ANALYSIS - I 
1 
 
 
 
 
 
 
 
 
 
 
 
Lesson : TARIFF ANALYSIS-I 
Lesson Developer: Amit Girdharwal 
College / University: Dyal Singh College (University Of Delhi) 
 
 
 
 
 
 
 
 
 
 
 
 
Page 2


TARIFF ANALYSIS - I 
1 
 
 
 
 
 
 
 
 
 
 
 
Lesson : TARIFF ANALYSIS-I 
Lesson Developer: Amit Girdharwal 
College / University: Dyal Singh College (University Of Delhi) 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
2 
 
 
Table of Contents: 
1. Introduction 
2. Types of tariffs 
3. Effects of tariffs 
   a. Partial Equilibrium Analysis: 
Case of large country    
   b. General Equilibrium Analysis: 
Small country and large country 
4. Arguments for Tariffs 
5. Exercise 
6. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Page 3


TARIFF ANALYSIS - I 
1 
 
 
 
 
 
 
 
 
 
 
 
Lesson : TARIFF ANALYSIS-I 
Lesson Developer: Amit Girdharwal 
College / University: Dyal Singh College (University Of Delhi) 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
2 
 
 
Table of Contents: 
1. Introduction 
2. Types of tariffs 
3. Effects of tariffs 
   a. Partial Equilibrium Analysis: 
Case of large country    
   b. General Equilibrium Analysis: 
Small country and large country 
4. Arguments for Tariffs 
5. Exercise 
6. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
3 
 
 
Learning Goals: 
After reading this chapter, you will be able to: 
• Understand the meaning of various types of tariffs, their problems of 
measurement and the effects of tariffs. 
• General equilibrium analysis of Tariff. 
• Political economy of Tariff barriers, arguments for imposing tariffs. 
• The domestic market failure argument for a tariff. 
 
Introduction 
Tariffs, the most common and widely used instrument of commercial policy,have been 
used by a country with the twin objectives of providing shield to the domestic industry 
against the foreign competition and generating income for the country. In the globalised 
world, tariffs have become one of the most important tools of international trade 
policiesand most debatable objects in economic policies under various international 
economic agreements. In this chapter we will discuss various types of tariffs, problems 
of measurement and their effects. 
Types of Tariffs: 
There are various types of tariffs, depending upon the ways of imposing, objectives, or 
retaliation. Specific tariffs are levied as a fixed charge for each unit of good imported (for 
example Rs 100 per unit). When the duty is levied on the basis of the value of the 
product measured by their price, they are calledad valorem tariff. Sometimes countries 
impose different rates of duty depending upon the foreign economic policy or relations, 
this type of tariff is called discriminatory tariff. For example, India imposes high rates of 
tariffs on goods coming from, say, European Union and lower rates of duty on goods 
coming from SAARC countries. 
Revenue tariffs are imposed for generating revenue for the economy. However,in 
commercial policy, tariff is meant for providing protection to the indigenous industries 
from foreign competition and they are called protective tariffs. 
Other types of tariffs are retaliatorytariffs and countervailing tariffs. When a country X 
imposes or increases the duties against the goods imported from country Y, it is possible 
Page 4


TARIFF ANALYSIS - I 
1 
 
 
 
 
 
 
 
 
 
 
 
Lesson : TARIFF ANALYSIS-I 
Lesson Developer: Amit Girdharwal 
College / University: Dyal Singh College (University Of Delhi) 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
2 
 
 
Table of Contents: 
1. Introduction 
2. Types of tariffs 
3. Effects of tariffs 
   a. Partial Equilibrium Analysis: 
Case of large country    
   b. General Equilibrium Analysis: 
Small country and large country 
4. Arguments for Tariffs 
5. Exercise 
6. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
3 
 
 
Learning Goals: 
After reading this chapter, you will be able to: 
• Understand the meaning of various types of tariffs, their problems of 
measurement and the effects of tariffs. 
• General equilibrium analysis of Tariff. 
• Political economy of Tariff barriers, arguments for imposing tariffs. 
• The domestic market failure argument for a tariff. 
 
Introduction 
Tariffs, the most common and widely used instrument of commercial policy,have been 
used by a country with the twin objectives of providing shield to the domestic industry 
against the foreign competition and generating income for the country. In the globalised 
world, tariffs have become one of the most important tools of international trade 
policiesand most debatable objects in economic policies under various international 
economic agreements. In this chapter we will discuss various types of tariffs, problems 
of measurement and their effects. 
Types of Tariffs: 
There are various types of tariffs, depending upon the ways of imposing, objectives, or 
retaliation. Specific tariffs are levied as a fixed charge for each unit of good imported (for 
example Rs 100 per unit). When the duty is levied on the basis of the value of the 
product measured by their price, they are calledad valorem tariff. Sometimes countries 
impose different rates of duty depending upon the foreign economic policy or relations, 
this type of tariff is called discriminatory tariff. For example, India imposes high rates of 
tariffs on goods coming from, say, European Union and lower rates of duty on goods 
coming from SAARC countries. 
Revenue tariffs are imposed for generating revenue for the economy. However,in 
commercial policy, tariff is meant for providing protection to the indigenous industries 
from foreign competition and they are called protective tariffs. 
Other types of tariffs are retaliatorytariffs and countervailing tariffs. When a country X 
imposes or increases the duties against the goods imported from country Y, it is possible 
TARIFF ANALYSIS - I 
4 
 
that country Y retaliates and levies duty on goods imported from country X. Country Y’s 
tariffs are then called retaliatorytariffs. On the other hand tariffs are said to be 
countervailing when a country imposes import duties with a view to offset export subsidy 
in the country of origin. For example, India imposes duty on Chinese products because 
India observes that china may use predatory dumping or provide the export subsidies to 
their exporters supplying goods to India. The countervailing duties are mainly aimed at 
wiping out unfair to advantages given by export subsidies in the foreign country. 
? Effects of Tariffs (Partial Equilibrium Analysis): 
 First we will analyze here effects of tariffs in case of small country and single commodity 
and later we will broaden our view by taking two countries and derive the import 
demand curve and export supply curve and then we will discuss the effect of tariff. 
When a small country imposes tariff on its imported good, it does not affect the price of 
the commodity in the rest of the world. The effect of the tariff is explained with the help 
of following diagram. D and S curves are domestic demand and domestic supply curve of 
the commodity. OP1 represents the world price at which the foreign producers are ready 
to supply any amount of the commodity in the domestic market. 
Case 1: Small Country 
 
 
Thus P
1
F, which is perfectly elastic, becomes the supply curve of the imports. Thus under 
free trade i.e. before imposing the tariff, the equilibrium is achieved at F, at which 
domestic demand curve and foreign supply curve intersect each other. The total demand 
for good is OQ
4
, out of which OQ
1
 is supplied by domestic producers and rest Q
1
Q
4
 is 
supplied by foreign producers. 
Page 5


TARIFF ANALYSIS - I 
1 
 
 
 
 
 
 
 
 
 
 
 
Lesson : TARIFF ANALYSIS-I 
Lesson Developer: Amit Girdharwal 
College / University: Dyal Singh College (University Of Delhi) 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
2 
 
 
Table of Contents: 
1. Introduction 
2. Types of tariffs 
3. Effects of tariffs 
   a. Partial Equilibrium Analysis: 
Case of large country    
   b. General Equilibrium Analysis: 
Small country and large country 
4. Arguments for Tariffs 
5. Exercise 
6. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TARIFF ANALYSIS - I 
3 
 
 
Learning Goals: 
After reading this chapter, you will be able to: 
• Understand the meaning of various types of tariffs, their problems of 
measurement and the effects of tariffs. 
• General equilibrium analysis of Tariff. 
• Political economy of Tariff barriers, arguments for imposing tariffs. 
• The domestic market failure argument for a tariff. 
 
Introduction 
Tariffs, the most common and widely used instrument of commercial policy,have been 
used by a country with the twin objectives of providing shield to the domestic industry 
against the foreign competition and generating income for the country. In the globalised 
world, tariffs have become one of the most important tools of international trade 
policiesand most debatable objects in economic policies under various international 
economic agreements. In this chapter we will discuss various types of tariffs, problems 
of measurement and their effects. 
Types of Tariffs: 
There are various types of tariffs, depending upon the ways of imposing, objectives, or 
retaliation. Specific tariffs are levied as a fixed charge for each unit of good imported (for 
example Rs 100 per unit). When the duty is levied on the basis of the value of the 
product measured by their price, they are calledad valorem tariff. Sometimes countries 
impose different rates of duty depending upon the foreign economic policy or relations, 
this type of tariff is called discriminatory tariff. For example, India imposes high rates of 
tariffs on goods coming from, say, European Union and lower rates of duty on goods 
coming from SAARC countries. 
Revenue tariffs are imposed for generating revenue for the economy. However,in 
commercial policy, tariff is meant for providing protection to the indigenous industries 
from foreign competition and they are called protective tariffs. 
Other types of tariffs are retaliatorytariffs and countervailing tariffs. When a country X 
imposes or increases the duties against the goods imported from country Y, it is possible 
TARIFF ANALYSIS - I 
4 
 
that country Y retaliates and levies duty on goods imported from country X. Country Y’s 
tariffs are then called retaliatorytariffs. On the other hand tariffs are said to be 
countervailing when a country imposes import duties with a view to offset export subsidy 
in the country of origin. For example, India imposes duty on Chinese products because 
India observes that china may use predatory dumping or provide the export subsidies to 
their exporters supplying goods to India. The countervailing duties are mainly aimed at 
wiping out unfair to advantages given by export subsidies in the foreign country. 
? Effects of Tariffs (Partial Equilibrium Analysis): 
 First we will analyze here effects of tariffs in case of small country and single commodity 
and later we will broaden our view by taking two countries and derive the import 
demand curve and export supply curve and then we will discuss the effect of tariff. 
When a small country imposes tariff on its imported good, it does not affect the price of 
the commodity in the rest of the world. The effect of the tariff is explained with the help 
of following diagram. D and S curves are domestic demand and domestic supply curve of 
the commodity. OP1 represents the world price at which the foreign producers are ready 
to supply any amount of the commodity in the domestic market. 
Case 1: Small Country 
 
 
Thus P
1
F, which is perfectly elastic, becomes the supply curve of the imports. Thus under 
free trade i.e. before imposing the tariff, the equilibrium is achieved at F, at which 
domestic demand curve and foreign supply curve intersect each other. The total demand 
for good is OQ
4
, out of which OQ
1
 is supplied by domestic producers and rest Q
1
Q
4
 is 
supplied by foreign producers. 
TARIFF ANALYSIS - I 
5 
 
Now suppose the country decides to impose specific tariff on the imported commodity by 
P
1
P
2
. Since the tariff imposing country is small, it does not affect the foreign export 
price. The tariff simply increases the price of the imported good by the full amount of the 
tariff. As a result the price of the commodity increases by the P
1
P
2
 and the new price is 
OP
2
. Thus P
1
P
2
 is the price effect of the tariff. After imposition of tariff the equilibrium 
consumption point moves from F to C. Because of increase in price domestic demand 
falls from OQ
4
 to OQ
3
 and domestic supply increases from OQ
1
 to OQ
2
. The new domestic 
production equilibrium is at d. The total amount of good imported is reduced from Q
1
Q
4
 
to Q
2
Q
3
. 
Protective or Production Effect:  The protective effect of tariff is measured by 
increase in domestic supply of the good after the tariff is imposed. In the fig.1 we can 
see that after tariff,Q
1
Q
2
 measures the protective or production effect. When price 
increases from OP
1
 to OP
2
, the domestic producers are able to cover rising marginal cost 
and they expand their production.Producer’s surplus is increased by area P
1
P
2
dE. 
Consumption Effect: The consumption effect shows that after levying the tariff, the 
consumption of the good decreases because of increase in price. There is a net loss of 
consumer surplus. In the fig. 1 we can see that before tariff the consumption or demand 
for good was OQ
4
, but after tariff, the consumption decreases from OQ
4 
to OQ
3
 and loss 
of consumer surplus is area P
1
P
2
cF. 
The combined production and consumption effect is called trade effect. Reduction in 
consumptionQ
3
Q
4
 and increase in production Q
1
Q
2
results in lower imports. Imports 
shrink from Q
1
Q
4
 toQ
2
Q
3.
 
Revenue Effect: The revenue effectis the revenue earned by the government by the 
tariff imposed i.e. P
1
P
2
 multiplied by Q
2
Q
3
. The area of rectangular abcd is the revenue 
effect. 
Redistribution Effect:The redistribution effect results from the producers receiving 
higher price after imposing the tariff. This is shown in figure 1 by the area P
1
P
2
dE. This 
amount is a surplus over production costs accruing to the domestic supplier. In this 
sense, producers gain a surplus P
1
P
2
DE out of the loss of consumer surplus due to the by 
the consumption effect is P
1
P
2
cF. Out of  the balance loss of consumer surplus the 
amount shown by area abcd accrues to the government  as revenue and the net loss of 
consumer surplus is represented by the two triangles Ead and Fcb. This loss of consumer 
surplus is neither transferable to producers nor to the government and is called 
“deadweight loss of the tariff”.